Professional Documents
Culture Documents
UNIT I
INTRODUCTION TO ACCOUNTING
Definition of Book-keeping:
In the words of A.H. Rosenkampff, “Book-keeping is the art of recording business transactions in a systematic manner”.
According to Northcot, “Book-keeping is the art of recording in the books of account the monetary aspect of commercial
and financial transactions”.
Book-keeping means the recording of business transactions in the books of account or account books in accordance with the
principles of accountancy.
Meaning of Accounting:
Accounting is identifying, measuring, recording, classifying and summarizing business transactions, analysing and
interpreting the results thereof, and communicating the results of the interpretations to the end-users for decision-making.
Definition of Accounting:
In the words of Bierman and Derbin, “ Accounting may be defined as the identifying, measuring, recording and
communicating of financial information”.
Meaning of Accountancy:
Accountancy is the science of accounting, which explains why books of accounts should be maintained, how to maintain the
books of accounts, how to prepare the financial statements, how to interpret the financial statements, and how to
communicate the results of the interpretation to the end-users.
Definition of Accountancy:
According to F.W.Pixley, “ the discipline which analyses the art and principle of recording all monetary transactions is
known as accountancy.”
1. Owners or Shareholders:
The owners of a business, who have invested capital, are naturally interested in knowing the rate of return they would get on
their capital. They are also interested in knowing the long-term solvency and the financial stability of their business,
which is an index of safety of their capital. They are even interested in knowing the progress of their business. To know
all these details, they are interested in accounting information or financial information about their business.
2. Prospective or Potential Investors:
Prospective or Potential Investors (i.e., persons desirous of investing money on the shares and debentures of a company or
joining a firm as partners) require accounting information on the financial stability (i.e., safety) and the past and the
present earnings (i.e., profitability) of an enterprise for deciding about the desirability or otherwise of investing funds in
the enterprise.
3. Debenture Holders:
The debenture holders of a company, who have provided long-term finance, are interested in accounting information about
the company to know its short-term solvency or liquidity (i.e., the ability of the company to pay the interest on
debentures periodically) and also its long-term solvency (i.e., the ability of the company to repay the debentures, when
they become due for repayment).
Commercial banks and other financial institutions are interested in financial information about the borrowing concern to
know its liquidity or short-term solvency (i.e, the ability of the concern to repay its short-term liabilities within short
period) as well as its long-term solvency (i.e., its long-term financial position to pay its long-term loans on the due
date). They are even interested in knowing the trends in the earnings of the borrowing concern, because the earnings of
the concern indicate its ability to repay its debts.
5. Creditors:
Creditors (i.e., supplier of goods and services on credit) of a concern are interested in the financial information about the
concern to know its liquidity (i.e., the ability of the concern to repay its short-term liabilities out of its current assets or
short-term assets).
6. Customers:
The customers (i.e., purchasers of goods on credit) of a concern, who wish to maintain long-term contacts with the concern,
are interested in the financial information about the concern to know its financial strength and stability.
7. Management:
Management (i.e., managers) of a concern requires accounting information about the concern for discharging efficiency
their functions of planning, decision-making and controlling. They require financial information also for evaluating
their efficiency in managing their concern.
8. Employees:
The employees of a concern like to have accounting information about the financial stability of their concern so that they
can have clear idea about the security of their jobs. They are also interested in knowing the earnings of their enterprise
so that they can bargain for higher salaries and allowances and bonus, when the earnings of the concern are large.
9. Government:
The Government is interested in the accounting information about every business concern for the purpose of collecting
taxes. The Government requires accounting information about each business concern also for controlling the prices of
products and for regulating the activities of each concern.
10. Consumers:
The consumers of the products of a concern are interested in the financial statements of the concern to know the costs of the
products produced by the concern and the profit made by the concern to decide about the amount of price reductions
which they can demand, when the prices charged by the concern are high.
11. Stock Exchanges:
Stock exchanges are interested in the financial data about companies, whose securities are listed in stock Exchanges, to
ascertain the performance and the prospects of those companies for protecting the interests of the investors.
12. Security or Investment Analysis:
Security or Investment analyses are interested in the financial statements of a company to advise their clients whether to
buy, hold or Sell the securities of that company.
13. Economists and Researchers:
Economists and researchers are interested in the accounting information contained in the financial statements of a business
concern for their study and research.
14. General Public:
Even the general publics are interested in the financial statements of a concern to know its progress and social contribution
(i.e., the contribution made by the concern to the welfare of the society at large).
Objectives of Accounting:
a. Cash transactions
b. Credit transactions
c. Barter transactions
d. Paper transactions
Cash Transactions:
A cash transaction refers to any business transaction where the value of the transaction is settled in cash immediately or
readily.
Example:
Credit transactions:
A credit transaction is a business transaction where the value of the transaction is not settled immediately, but its settlement
is postponed to a future date.
Example:
Entity:
The term ‘entity’ means something or someone having a separate existence. In other words, the term means a thing or a
person having a definite separate existence. For instance, ‘business entity’ means a specially identifiable business
enterprise.
Capital:
The account of money or money’s worth, say, stock of goods, furniture, machinery, etc. invested or introduced by the
proprietor into his business at the time of the commencement of business is called capital.
Drawings:
Drawings refer to cash, goods or any other asset withdrawn by the proprietor from his business for hid personal, private or
domestic use or purpose.
Assets:
Robert N. Anthony, “ Assets are valuable resources owned by a business which were acquired at a measurable money cost”.
Liabilities:
Liabilities are outsiders’ equity (i.e., outsiders’ claims against the assets of a business concern). For this reason, liabilities
are also termed as outsider’s equity.
Debtor:
A debtor is a person who owes money to the business. He owes money to the business because he has received some benefit
from the business. A debtor constitutes an asset for the business.
Bad Debt:
A debt which is irrecoverable (i.e., cannot be realized) is called bad debt. Bad debt is a known loss to the business. So, the
actual known bad debt is charged or debited to profit and loss account.
Creditors:
A creditor is a person to whom the business owes money. The business owes money to him, because he has given some
benefit to the business. A creditor constitutes a liability for the business.
Goods:
Good refer to merchandise, commodities, products, articles or things in which a trader deals. In other words, they refer to
commodities or tings meant for resale. For example, for stationary merchant, stationary articles like books, pens,
pencils, ink, paper, etc. are his goods, for a furniture dealer, furniture, such as tables, chairs, benches, cupboards, cots,
etc. are his goods. And for a cloth merchant, cloths are his goods.
Purchases:
Sales:
Goods sold by a business are called sales. The sales of goods may be cash sales or credit sales. The sales of goods are
recorded in sales account.
Inventory or Stock:
Inventory or stock refers to the stock of finished goods held for sale in the ordinary course of business, or the stock of raw
materials and work-in-progress (i.e., partly finished goods) held for consumption in the production of finished goods for
sale, or stock of consumable stores like cotton waste, grease, lubricant, etc. held for use in the factory.
Expenses:
In the words of Robert N. Anthony, “Expenses are the costs incurred in connection with the earnings of revenue.”
Expenditure:
The amount of money spent, or the amount of an obligation or liability incurred, or the amount of a property transferred for
the acquisition of an asset or for the enjoyment of a service.
Loss:
Loss refers to money or money’s worth given up without getting any benefit in return.
Revenue or Income:
Revenue or income is the earning of a business from the sale of goods or from the rendering of services to customers during
an accounting period.
Gain:
Gain refers to revenue which is not generated through routine or regular business activities.
Profit:
Profit is the excess of revenues over the expenses of a given period of time, usually a year. For this reason, profit is also
termed as net profit.
Debit:
Credit:
Discount:
Discount means is a reduction in the selling price of goods allowed business to its customers, or a reduction in the amount
due allowed by the creditors to its debtors.
Voucher:
i. Identifying:
Identifying is an essential aspect of accounting. Identifying means determining the business transactions to be recorded in
the books of account.
ii. Measuring:
Measuring is another essential aspect of accounting. Measuring means determining the business transactions in terms of
money.
iii. Recording:
Recording is another essential aspect of accounting. Recording means entering, in terms of money, business transactions, as
and when they occur, either in a single book of original entry called the journal or in several books of original entry
called subsidiary books. In short recording means recording business transactions in the book or books of original entry.
iv. Classifying:
Classifying is another important aspect of accounting. Classifying refers to the grouping of entries of like nature into
appropriate heads by posting them from the book or books of original entry to appropriate accounts in the ledger. In
other words, it means the classification of the entries in the journal or subsidiary books into appropriate accounts in the
ledger. In short, it means the preparation of the necessary ledger accounts.
v. Summarizing:
Summarizing means summarizing the effects of the business transactions, classified in the ledger, upon the profit and the
financial position of the business. In other words, summarizing means the presentation of the information found in the
ledger accounts in the form of financial statements like the profit and loss account and the balance sheet at the end of
the accounting period. In short, it means the preparation and presentation of financial statements.
Analyses and interpretation is yet another essential aspect of accounting. Analysis and interpretation means rearrangement
of the information found in the financial statements in a suitable manner, and drawing meaningful conclusions about
the profit, the financial position and the future prospects of the business.
vii. Communicating:
Communicating is one of the essential aspects of accounting. Communicating means communicating the results of
interpretation of financial statements to the end-users for decisionmaking.
Book-keeping Accounting
1. Book-keeping is just the process of recording 1. Accounting comprises the recording of business
business transactions in the books of Account. transactions in books of account, the preparation
of financial statements and the analysis and
interpretation of the financial statements.
2. Book-keeping is the first stage of maintenance of 2. Accounting is the second stage of maintenance of
books of account. books of account.
Book-keeping Accountancy
1. Book-keeping is a part or branch of accountancy. 1. Accountancy is the basic subject covering
2. Book-keeping is mainly the art of recording book-keeping and accounting.
business transactions. 2. Accountancy is the science, prescribing the
principles to be observed while recording
business transactions.
3. Book-keeping has to observe the principles of 3. Accountancy lays down the rules of recording
recording transactions laid down by accountancy. business transactions for book-keeping.
4. Book-keeping is mostly an art.
4. Accountancy is a science.
5. Book-keeping cannot be regarded as a discipline 5. Accountancy is a discipline or subject of study.
or subject of study.
6. Accountancy work is of technical and
6. Book-keeping work is of routine and clerical complicated nature.
nature.
7. Accountancy is the work or profession of skilled
7. Book-keeping is the work of ordinary account professional accountants called charted
clerks. accountants.
Accountancy Accounting
1. Accountancy is a discipline (i.e., a branch of 1. Accounting is the science and art of actual
knowledge or a subject of study), consisting recording, classifying, summarizing and
of certain principles or rules governing the analyzing financial transactions according to
science and art of recording classifying, the principles of accountancy.
The theory base of accounting means and consists of concepts, conventions, principles or guidelines developed by
professional bodies and academicians over a period of time to bring uniformity and consistency to the process of
accounting and enhancing its utility to the different end-users of accounting information.
The accounting standards issued by the Institute of Chartered Accountants of India for imparting, uniformity
and consistency to accounting policies and practices also constitute a part of theory base of accounting.
Meaning of GAAPs:
In order to maintain uniformity and consistency in accounting records, certain principles or rules have been developed
and are widely accepted by the accounting profession. Such accounting principles are called generally accepted
accounting principles. So, generally accepted principles are a set of principles and practices that are followed in
recording business transactions in books of account and in preparing and presenting financial statements at a given time.
A principle is a rule of action or guide to action. So, accounting principles are broad guidelines or rules of action followed
in the preparation of accounts and in the presentation of financial statements. In other words, they are the set of rules or
principles followed in recording transactions in he books of account and in preparing financial statements. In short, they are
the principles or rules which provide the theory base for accounting practices.
Definition:
According to the American Institute of Certified Public Accountants (AICPA), U.S.A., “An accounting principle is a
general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice”.
1. Accounting concepts
2. Accounting Conventions
The term ‘concept’ means an idea or thought. So, accounting concepts are the fundamental ideas or basic assumptions
underlying the theory and practice of accounting. In other words accounting concepts are the broad working rules of
accounting practices.
According to this concept only those transactions, which can be expressed in monetary terms, are recorded in the
accounting book.
According to this concept, business is treated as an entity different from the owner. The transaction that take place
affect the business and not the owner.
3. Going-concern concept:
According to this concept the business will continue for a long period to come and it is not likely to be liquidated in the
near future.
4. Cost concept:
According to this concept, assets purchased are general recorded in the accounting books at the cost at which they are
purchased.
Assets = Liabilities
This concept is simply intend for a periodical ascertainment and reporting of the results of the working of
the firm/business.
This concepts means that all accounting entries should be evidenced and supported by source documents or
business documents, such as invoices, vouchers, etc.
8. Realization concept:
According to this concept, revenue is recognized only when the sale is performed.
9. Accrual concept:
According to this concept all incomes and expenses should be recorded in the books of accounts when they paid.
The matching concept is that, to the extent feasible, costs are reported as expenses in the period in which the
associated revenue is reported.
ACCOUNTING CONVENTIONS:
Accounting conventions are the customs practices which have been in force for a long period and which guide the
accountants, while preparing financial statements like the profit and loss account and the balance sheet. In the
other words, they are the customs, usages or practices followed by accountants as a guide in the preparation of
financial statements.
1. Convention of materiality:
The convention of materiality means that, in accounting, a detailed record is made only of those business
transactions which are material (i.e., significant) to the users of accounting information.
2. Convention of conservation:
The convention of conservation means the convention of caution, prudence or the policy of playing safe. In the
other words, it means, in the accounting records and the financial statements of a business, all the prospective
losses, risks and uncertainties should be taken note of and provided for, but prospective profits should be ignored.
3. Convention of consistency:
The convention of consistency means that the accounting practices and methods should remain consistent
(i.e., unchanged) from one accounting year to another.
The convention of disclosure means that the material facts must be disclosed in the financial statements with
sufficient details.
Single-entry system:
Meaning:
When the rules of double entry system of accounting ar not followed completely for recording business transactions, the
accounting system is called incomplete accounting system or Single-entry system.
Definition:
Eric Kohler defines accounts from incomplete records or single entry system as “ a system of book-keeping in which, as a
rule, only records of cash and of personal accounts are maintained. It is always incomplete double entry varying with
circumstances.”
1. Under the single entry system, all the transactions of a business are not recorded in the books of account.
2. No hard and fast rules are observed for recording business transactions.
3. There is no uniformity under this system as regards the recording of business transactions by different concerns.
4. Flexibility in recording is one of the important features of single entry system.
5. Source documents play a very important role in the case of single entry system.
6. Under this system, all accounts are not maintained.
7. The cash book, maintained under this system, usually, mixes up the business transactions as well as the private
transactions of the proprietor.
8. This system gives only partial or incomplete information, and not full information about the business.
9. This system is an incomplete, unscientific, unsatisfactory and unreliable system of Accounting.
10. It is a simple and economical system of Accounting.
11. It is usually, adopted by small business concerns.
Double Entry system is a system, which is recorded, scientific, satisfactory and systematic system of Book-keeping. For
each contracting parties, a business transaction involves exchange of equal values or benefits, i.e., the receiving of some
benefit (say some commodity, right or service) of some value, and the giving of some other benefit (i.e., some other
commodity right or service) of equal value.
Basis of Accounting:
Basis of accounting refers to the basis, approach or method under which business transactions are recorded in the books of
accounts of a business, and the annual results (i.e., net profit or net loss and the financial position) of the business are
ascertained.
In the other words, cash basis of accounting is a basis, approach or method of accounting under which entries for recording
the transactions of a business are made only when cash is actually received or actually paid for those transactions.
Accrual basis of accounting is an approach or basis of accounting under which the revenues and expenses are recognized in
the period in which they accrue, and not in the period when they received or paid.
Thus, under this basis, the monetary effects of transaction are taken into account in the period when revenues are earned and
expenses are incurred, and not in the period when revenues are received in cash and expenses are paid in cash.
Mixed based or hybrid basis of accounting is a basis of accounting which is a mixture of both cash basis and accrual basis
of accounting. In other words, it is a basis of accounting under which some transactions are recorded on cash basis and
some transactions are recorded on accrual basis. Generally incomes are recorded on cash basis and expenses are recorded on
accrual basis.
The revenue account prepared under the hybrid basis of accounting, for ascertaining the profit or loss for the year, can be
even termed as “Receipts and Expenditure Account”.
ACCOUNTING EQUATION
The fundamental accounting equation, also called the balance sheet equation, represents the relationship
between the assets, liabilities, and owner's equity of a person or business. It is the foundation for the double-
entry bookkeeping system. For each transaction, the total debits equal the total credits. It can be expressed as
further more.
A=L
200000= 200000
A= L + C
200000= 60000+140000
A-L=C
200000-60000= 140000
A-C=L
200000-140000=60000
Accounting standards are the written statements consisting of rules and guidelines, issued by the accounting
institutions, for the preparation of uniform and consistent financial statements and also for other disclosures
affecting the different users of accounting information.
Accounting standards lay down the terms and conditions of accounting policies and practices by way of
codes, guidelines and adjustments for making the interpretation of the items appearing in the financial
statements easy and even their treatment in the books of account.
On the basis of forgoing discussion we can say that accounting standards are guide, dictator, service
provider and harmonizer in the field of accounting process.
Accounting standards serve the accountants as a guide in the accounting process. They provide basis on
which accounts are prepared. For example, they provide the method of valuation of inventories.
Accounting standards act as a dictator in the field of accounting. Like a dictator, in some areas accountants
have no choice of their own but to opt for practices other than those stated in the accounting standards. For
example, Cash Flow Statement should be prepared in the format prescribed by accounting standard.
Accounting standards comprise the scope of accounting by defining certain terms, presenting the accounting
issues, specifying standards, explaining numerous disclosures and implementation date. Thus, accounting
standards are descriptive in nature and serve as a service provider.
Accounting standards are not biased and bring uniformity in accounting methods. They remove the effect of
diverse accounting practices and policies. On many occasions, accounting standards develop and provide
solutions to specific accounting issues. It is thus clear that whenever there is any conflict on accounting
issues, accounting standards act as harmonizer and facilitate solutions for accountants.
In earlier days, accounting was just used for recording business transactions of financial nature. Its main
emphasis now lies on providing accounting information in the process of decision making.
Accounting is a language of business. There are many users of the information provided by accountants who
take various decisions relating to their field just on the basis of information contained in financial
statements. In this connection, it is necessary that the financial statements should show true and fair view of
the business concern. Accounting standards when used give a sense of faith and reliability to various users.
They also help the potential users of the information contained in the financial statements by disclosure
norms which make it easy even for a layman to interpret the data. Accounting standards provide a concrete
theory base to the process of accounting. They provide uniformity in accounting which makes the financial
statements of different business units, for different years comparable and again facilitate decision making.
Accounting standards prevent the users from reaching any misleading conclusions and make the financial
data simpler for everyone. For example, AS-3 (Revised) clearly classifies the flows of cash in terms of
‘operating activities’, ‘investing activities’ and ‘financing activities’.
Accounting standards prevent manipulation of data by the management and others. By codifying the
accounting methods, frauds and manipulations can be minimized.
Accounting standards lay down the terms and conditions for accounting policies and practices by way of
codes, guidelines and adjustments for making and interpreting the items appearing in the financial
statements. Thus, these terms, policies and guidelines etc. become the basis for auditing the books of
accounts.
(2) While formulation of standards ASB has to consider applicable laws, customs, social and business
environment.
(3) ASB has to give due consideration to IAS issued by IASC from time to time to develop own standards in
light of conditions and practices being followed in India.
(4) ASB has to persuade the accounting professionals and preparers of financial statements to adopt them.
The following steps are taken by ASB for issue of any accounting standard in India:
(2) Various study groups are formed by ASB to assist ASB to consider special subjects. However in forming
these groups provision is made for participation of members of institute and others.
(3) A discussion is arranged with representation of government agencies, public sector undertaking, industry
and other organisation.
(4) An exposure draft is prepared and issued for comments of general public.
(5) A standard draft is finalized by ASB after taking due consideration of the comments.
(7) The council may decide to modify the exposure draft in consultation of ASB.
(8) The accounting standard is then issued under the authority of council of institute.
1. Personal Accounts
These accounts are related to individuals, firms, companies, etc. A few examples of personal accounts
include debtors, creditors, banks, outstanding/prepaid accounts, accounts of credit customers, accounts of
goods suppliers, capital, drawings, etc.
Artificial personal accounts: Personal accounts which are created artificially by law, such as corporate
bodies and institutions, are called Artificial personal accounts. E.g. Pvt Ltd companies, LLCs, LLPs, clubs,
schools, etc.
Representative personal accounts: Accounts which represent a certain person or a group directly or
indirectly. E.g. Let’s say that wages are paid in advance to an employee – a wage prepaid account will be
opened in the books of accounts. This wages prepaid account is a representative personal account indirectly
linked to the person.
2. Real Accounts
All assets of a firm, which are tangible or intangible, fall under the category “Real Accounts“.
Tangible real accounts are related to things that can be touched and felt physically. Few examples of
tangible real accounts are building, machinery, stock, land, etc.
Intangible real accounts are related to things that can’t be touched and felt physically. Few examples of
such real accounts are goodwill, patents, trademarks, etc.
3. Nominal Accounts
Accounts which are related to expenses, losses, incomes or gains are called Nominal accounts. The
dictionary meaning of the word “nominal” is “existing in name only” and the meaning remains absolutely
true in accounting sense too, because nominal accounts do not really exist in physical form, but behind every
nominal account money is involved. E.g. Purchase A/C, Salary A/C, Sales A/C, Commission received A/C,
etc.
The final result of all nominal accounts is either profit or loss which is then transferred to the capital
account.
Companies are able to maintain a complete record of every transaction classified as assets, liabilities,
expenses, revenue, capital and recorded accordingly.
Allows companies to prepare financial statements easily as it is a scientific system of recording
business financial transactions in a set of accounting records.
The trial balance helps to maintain the accuracy of all books of accounts.
Narasimha Murthy H. Asst. Prof.. Presidency college Page 23
The financial position of a company can be ascertained at the end of each accounting period, through
the preparation of the balance sheet.
The matching principle allows companies to accurately assess the profit earned or loss suffered
during a period together with details by the preparation of Profit and Loss Account.
It provides checks and balances, which prevents frauds and misappropriations as complete
information about assets and liabilities are recorded.
Solicits comparative study of results of one year to another to ascertain reasons of change or for
decision making purposes.
Affords complete information for purposes of control permitting accounts to be maintained in as
much detail as necessary.
Disadvantages
Classification of accounts
In this book, all the regular business transactions are entered sequentially, i.e. as an when they arise. After
that, the transactions are posted to the Ledger, in the concerned accounts. When the transactions are
recorded in the journal, they are called as Journal Entries.
As per Double Entry System of Book Keeping, every transaction affects two sides, i.e. debit and credit.
So, the transactions are entered in the book as per the Golden Rules of Accounting, to know which account
is to be debited and which one is to be credited.
Format of Journal